2017 First Quarter Commentary

The first quarter was another strong one for stocks here and abroad. Emerging markets lead the way, up more than 11% for the quarter – almost doubling the S&P 500’s 6% return, with both European and Pacific region stocks also outperforming US markets. Here’s a quick look at market performance and valuation data across various regions and asset classes, with the recent numbers being another reminder of why international diversification is a good idea.

Markets Overview and Politics

Although some of the post-election US rally may have been attributable to what has been called the “Trump Bump” (based on the hope of a pro-growth, lower tax, anti-regulatory agenda), there are certainly larger forces at play. We see this in the strong performance of most quarters of the globe and the underlying message is one of strengthening economic data and sentiment everywhere (and in places where the new administration’s agenda would not be expected to have much, if any, positive impact. To wit: French, German and Japanese markets all outperformed the US in the past quarter.) In addition to strong global economic data fueling Europe’s performance, there is likely some relief around the upcoming French election expectations with independent centrist Emmanuel Macron showing better in recent polling than far-right National Front candidate, Marine LePen, and in the UK, perhaps some lessening of the anxiety around fallout from Brexit. However, both of those cakes have a while left to bake, and if we have learned anything from 2016, it’s that we shouldn’t be too terribly surprised by the unexpected.

Market valuations continue to be on the high side by historic norms (nothing new here), in part due to sentiment, and in part due to continuing low competing interest rates in the bond markets. US large and small company stocks are trading at 21 and 22 times earnings, respectively, with Europe at 20x, the Pacific region a relative bargain at 15x, and Emerging Markets a positively cheap-in-current-terms 14x.

Yet again, bond returns were relatively flat, although not negative despite much anticipation over the Fed’s second recent bump in the overnight rate, the rate which institutions charge one another for short-term loans. Although many investors worry about the effect a rising interest rate environment might have on their bond holdings and equity portfolios, rising rates tend to be coincident with strong economic growth and so often don’t have any consistently adverse impact on equity returns. For bond holders – especially short-term bond holders – the immediately negative impact rising rates may have on those holdings has historically been offset over time as lower yield maturing issues are rolled over into new higher yielding issues.

Although some of the market’s post-election run-up – at least in the US – may have been attributable to hopes around the GOP’s pro-business agenda, there has been some recent cooling of these expectations due to a rocky start for the Trump administration. Last month’s defeat of the American Health Care Act further cooled expectations as it highlighted deep divisions within the GOP and eliminated hoped-for tax savings that would have been in part used to fund proposed tax cuts. Those disappointments notwithstanding, it’s worth remembering that while election-related optimism may be receding, the rise in equity valuations we have seen over the last five months is more likely to due to larger and more global macroeconomic forces, as policy issues are not usually the driving force behind equity market returns one way or the other.

Politics, Retirement, and Health Insurance

One of the retirement-related issues I had been keenly watching last month was the outcome of the legislative battle around the possible repeal of the Affordable Care Act, more colloquially known as Obamacare. For those who retire at age 65 or beyond – or those fortunate enough to have company-provided health care in retirement (an increasingly rare retirement benefit if ever there was one), having access to reasonably affordable health insurance is and continues to be a non-issue thanks to Medicare and guaranteed-issue Medicare supplements. However, for many pre-65 retirees – or would-be retirees, access to health insurance was not a foregone conclusion prior to implementation of the ACA, and this issue alone kept many working until Medicare eligible when they otherwise might have retired earlier.

I’ll be the first to acknowledge the limitations of the ACA, the many problems with its implementation, and the complexity of the topic – political complexity as well as economic complexity. With that said, from a retirement planning perspective, I’m glad to have seen Congress not repeal the ACA without having a viable alternative in place, as I think the consequences would have been dire for millions, including some of those now and soon-to be early retirees. It remains to be seen if the GOP and current administration can come up with a workable (and politically palatable) alternative – or perhaps more reasonably, to fix any problems in the implementation of the current law.

Department of Labor (DOL) Fiduciary Rule

This topic is worthy of a longer discussion than what will follow, but given that the new DOL fiduciary rule was scheduled to go into effect on April 10th, I thought it worth at least a quick mention. By way of background, the DOL, which has broad oversight responsibility for workplace-related retirement plans – e.g., 401(s)s and 403(b)s – issued regulatory guidance two years ago that would require any service provider and/or advisor making recommendations to participants in such a plan (and, by extension, to IRA owners) to act as a fiduciary – i.e., to act in the best interest of the account owner. While one might have assumed that such a requirement already existed, in fact, it did not – not at least for most firms providing services to such workplace retirement plans.

Since the mandate was finalized, there have been several court challenges to the DOL’s fiduciary requirement, all of which have failed, and unsurprisingly there has been much wailing from large segments of the financial services industry (think commissioned annuity and other product-oriented sales people and/or large wire houses/brokerage firms), many of whom have insisted they won’t be able to adequately “serve” clients if they also must act in the client’s best interest. (I’m not sure how the logic of that works, but that is the primary argument that has been made against the rule.) In any case, this rule, which was scheduled to be implemented on April 10th, is now on a 60-day review and there has been an increasing expectation that this delay is a precursor to either a watering down of the rule or an outright regulatory repeal. I realize there is a balance to be had between regulation and choice in the marketplace, but I personally would be disappointed to see a step backwards from these much-needed investor protections. Regardless of the DOL rule’s outcome, I’ll take this opportunity to say that I and my firm, The Retirement Planning Specialists, which is a SEC-registered investment advisor, has been and will continue to be a full fiduciary with respect to ALL of our clients and all of the accounts we manage, and that the implementation or non-implementation of the DOL rule won’t have any effect on that status.

News Bias

Several years ago, I read the very worthwhile book Bias by veteran CBS news correspondent Bernie Goldberg. It was a worthwhile read, if for no other reason than the behind-the-scenes look at the news industry. In that book, Goldberg looked at various kinds of news bias we have all witnessed. Of course, depending on the day of the week and the news source you’re tuned into, there is likely to be some bias – left or right, liberal or conservative – and I think most would acknowledge that, unsurprisingly, such bias exists. However, I found the most salient point Goldberg made was about an ever-present negativity bias. After all, no one tunes into round-the-clock coverage of “It’s 70° and sunny, again.” It’s always the hurricanes, the floods and the plane crashes [2] that drive binge viewership.

Following the election, I was as steeped in the news as one could be and still hold a job, but even I – news junkie that I am – could only take so much of the chattering class in such a short period. I have since settled back into my more typical consumption pattern, which is to say, more reading and less watching/listening. So, with that confession out of the way, I’ll offer a gentle reminder to try to not wade too deeply into the quicksand of current events, political or otherwise, especially with respect to what such events might portend for markets and/or your portfolio. Short-term thinking too often wreaks havoc on what by design are long-term portfolios – and usually to no good end. (Just a reminder.)

News and politics notwithstanding, I hope you are enjoying Spring, which came early this year and looks to stay, and as always, please let me know if there is anything we can do for you.

Footnotes

[1] Indices used from top to bottom of list, all denominated in USD: MSCI Emerging Markets, S&P GSCI Gold, MSCI All Country World Index ex-US, MSCI Europe, MSCI Pacific, S&P 500, Dow Jones Real Estate, Russell 2000, Barclay’s Global Bond Aggregate, Barclay’s Global Aggregate Bond 1-3 (or 3-5) Years, SBBI Inflation, Barclays US Treasury 1-3 Year, and the S&P Goldman Sachs Commodity Index
[2] “We got the bubble-headed-bleach-blond Who comes on at five / She can tell you ’bout the plane crash with a gleam in her eye / It’s interesting when people die / Give us dirty laundry” (Don Henley, Dirty Laundry, Building the Perfect Beast, 1982). Here’s a link to the song on Youtube